William C. Hunter

The Past, Present, and Probable Future for Community Banks

We review how deregulation, technological advance, and increased competitive rivalry have affected the size and health of the U.S. community banking sector and the quality and availability of banking products and services. We then develop a simple theoretical framework for analyzing how these changes have affected the competitive viability of community banks. Empirical evidence presented in this paper is consistent with the models prediction that regulatory and technological change has exposed community banks to intensified competition on the one hand, but on the other hand has left well-managed community banks with a potentially exploitable strategic position in the industry. We also offer an analysis of how the number and distribution of community banks may change in the future.

Technical Change, Organizational Form, and the Structure of Bank Production

OF THOSE TECHNOLOGICAL CHARACTERISTICS RELATED TO the nature of competition among firms in an industry or market, scale economies and technical change are especially important. Economies of scale are said to exist when an equiproportional increase in all inputs results in a greater than proportional increase in output or equivalently when an increase in output at constant input prices leads to a less than proportional increase in total costs. Thus, average costs decline as output expands. Depending upon the extent to which costs decline as output increases, regulation of the firms in the industry may be necessary.l The literature analyzing scale economies in commercial banking is voluminous. The early studies on scale economies in banking include those by Benston (1965, 1972), Greenbaum (1967), Murphy (1972), and Bell and Murphy (1968). More recent studies include those by Benston, Hanweck, and Humphrey (1982) and Clark (1984).2 This literature has established that mild scale economies exist in bank

Efficiency of multinational banks: an empirical investigation

This paper conducts a comparative analysis of the productive efficiency of foreign-owned and US-owned multinational commercial banks operating in the US. A multiproduct translog stochastic-cost frontier model approach is used to estimate cost inefficiency scores. Ordinary Least Squares and Tobit regressions are used to identify the key factors associated with inefficiency. The results indicate that foreign-owned multinational banks operating in the US are significantly less efficient than their US-owned counterparts and that large multinational banks in holding company networks carrying fewer foreign assets tend to be more efficient.

Deregulation and efficiency: the case of private Korean banks

This paper examines the productive efficiency of a sample of private Korean banks over the 1985 to 1995 time period. The goal of the analysis is to identify the key determinants of Korean bank efficiency (inefficiency) following the program of deregulation initiated by the government in the early 1980s and augmented in the early 1990s. Using the stochastic frontier cost function approach, efficiency scores were determined for each bank in the sample. A second stage efficiency regression was then estimated to identify the key determinants of operating efficiency. In general, the results show that banks with higher rates of asset growth, fewer employees per million won of assets, larger amounts of core deposits, and lower expense ratios were more efficient. In addition, banks which branched nationwide were found to be more efficient. The financial deregulation of 1991 was found to have had little or no significant effect on the level of sample bank efficiency.

Core deposits and physical capital: a reexamination of bank scale economies and efficiency with quasi-fixed inputs

This paper compares measures of bank production efficiency assuming all bank inputs are completely variable with measures obtained from specifications which take account of the quasi-fixed nature of core deposits and bank physical capital, and the treatment of certain deposits as outputs. The empirical results imply that scale economy measures vary substantially for small to medium-sized banks whereas those for the largest banks are fairly robust to the different specifications. Estimates of economies of scope were found to be invariant to different input/output specifications, whereas efficiency measures varied significantly with changes in the specification of the cost function and with the definition of outputs and inputs. Copyright 1995 by Ohio State University Press.

The Cultural Affinity Hypothesis and Mortgage Lending Decisions

This paper conducts an empirical analysis of the cultural affinity hypothesis put forth by Calomiris, et al. (1994) in the mortgage lending market. This hypothesis implies that white loan officers, because of a lack of familiarity with minority applicants, will rely more heavily on characteristics that can be observed at low cost (e.g., objective loan application measures) in evaluating the creditworthiness of minority applicants relative to white applicants. Using a cleansed sample of 1,991 loan applications drawn from data collected by the Federal Reserve Bank of Boston, the results of the analysis were consistent with the cultural affinity hypothesis. In particular, we found that marginal black and Hispanic applicants appeared to be held to higher quantitative standards on such objective factors as credit history and debt obligation ratios than were similarly situated marginal white applicants.

An analysis of advisor choice, fees, and effort in mergers and acquisitions

Abstract This paper investigates the choice of financial advisors in mergers and acquisitions, the fees that the targets and the acquiring firms pay to these advisors, and the speed with which advisors complete transactions. Our sample includes 5337 merger deals announced during the period January 1995 to June 2000, that involved publicly traded targets and acquirers. We find that top-tier advisors are more likely to complete deals and to complete them in less time than lower tier advisors. However, the synergistic gains realized by the acquirers declined when top advisors were used. We also find that contingent fees play a significant role in expediting the deal completion. Surprisingly, we find that deals that are initiated by the advisors do not seem to take less time to complete. Our results suggest that the payment of larger advisory fees do not play an important role in determining the likelihood of completing the deal, but they are associated with greater acquisition gains realized by the acquirer. In addition, these synergistic gains are also associated with the switching by acquirers of their financial advisors within the same tier.

Technological change in large U.S. commercial banks

This article examines technological change, its relationship to firm size, and its impact on the efficient scale of output and product mix for large U.S. commercial banks. The results suggest that technological change lowered real costs by about one percent per year, increased the cost-minimizing scale of outputs, and affected product mix. The authors do not find support for the Galbraith-Schumpeter hypothesis. This suggests that the largest banks cannot use innovation alone to outpace smaller banks. The major implications are that public policies allowing freer banking combinations do not necessarily run counter to the public interest. Copyright 1991 by University of Chicago Press.

Does the Japanese Stock Market Price Bank-Risk? Evidence from Financial Firm Failures

The ability of the Japanese stock market to appropriately price the riskiness of Japanese financial firms has been frequently questioned, particularly in light of Japan’s widespread financial distress in recent years and poor disclosure requirements. This paper examines the response in equity returns of Japanese banks to the failure of four commercial banks and two securities firms between 1995 and 1998. Using event study methodology, the analysis finds that share prices of surviving banks on the whole responded unfavorably to the failures and that financially weaker survivors were more adversely affected. This suggests that, despite the distress and alleged opaqueness, bank shareholders were able to use available indicators of financial condition both to incorporate new information quickly into stock prices and to differentiate among banks.

Deregulation, the Internet, and the Competitive Viability of Large Banks and Community Banks

Deregulation, technological change, and increased competitive rivalry are transforming U.S. commercial banking from an industry dominated by thousands of small, locally focused banks into an industry where a handful of large banks could potentially span the nation and control the majority of its bank deposits. This paper examines the comparative strengths and weaknesses of large and small banks in this new environment, and outlines the strategic opportunities and threats that new technology - especially the Internet - pose for U.S. banks. We begin by documenting recent trends in bank size, industry structure, competitive conditions, and bank product mix. We argue that these trends are consistent with a simple competitive strategy framework in which commercial banks choose between two profitable business strategies: (a) a community bank business model in which banks have a local focus, a high cost structure, and sell low volumes of personalized service at high margins, and (b) a global bank business model in which banks have a national or international focus, a low cost structure, and sell high volumes of standardized financial products at low margins. Finally, we discuss how Internet banking is likely to affect this strategic equilibrium. In particular, we analyze how a shift away from brick and mortar branches and toward the Internet delivery channel will reduce the switching costs that currently dissuade retail deposit customers from changing banks. Based on the foregoing analysis, we conclude that the number of small banks will continue to decline in the future - not because the community bank business model is flawed, but because most of the small banks that use this model are poorly run. In the long-run, our analysis suggests that well-run community banks should be able to adapt their business practices to technological change and profitably co-exist with large, globally focussed banks.